Gotta watch those widget sales

I had a question from a class participant a few days ago, and it was such a good question, I thought I'd use it here.  But I promised her I'd sanitize the heck out of it.  So think of this as a question "inspired" by the real question.

"My company is an HVAC contractor [in most states, contractor sales aren't taxable - they pay tax on the building materials they use].  We prepare widgets in our shop that will be attached to the HVAC equipment.  Since it's part of the construction job, we just cost the materials used for the widgets to the job and pay sales tax on the few hunks of steel that we use.  

However, we have a lot of customers who buy the widgets without our doing any actual HVAC work (our widgets are very popular and user installable).   When this happens, we just send the widget to the customer, and bill them.  We don't charge sales tax. Should we?"

You should be charging tax on the widgets that you sell at retail to your customers. If the widgets become part of the building where you're doing the HVAC work, then you would pay tax on the widget components when purchased. 

But when you sell the widgets outside of a construction contract, you are making retail sales of tangible personal property, and those are taxable sales.  You should be charging tax.

The problem is that, if you've already paid tax on the components of the widget when you bought them, and then you collect tax on your retail sales of them, then the state is getting too much money. In most states, there are two solutions (and you need to check your state rules to make sure of your options):

Purchases resold - Many states make provision for purchases you make that were taxed, and are subsequently sold at retail where tax is collected.  The states usually let you deduct your "purchases resold" from your use tax liability.

Buy for resale - If your retail sales of widgets are substantial, consider giving your vendor a resale certificate for all of the widget components and pay no tax on any of those purchases.  Then collect tax on your retail sales and accrue use tax on the materials that become part of your construction contracts.

Either way, there is extra bookkeeping involved.  But if the retail sales of the widgets are substantial, you should come up with a solution before the next auditor finds it.

This is another example of a situation where a business was making taxable retail sales without even realizing it.  Does anyone else have this problem?   You betcha!

And finally, if you are actually manufacturing the widget, you should look into whether or not there are any manufacturing exemptions available to you.

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The Sales Tax Guy
http://salestaxguy.blogspot.com

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Withdrawal from Stock

This is a continuation of the topic started in this article and a variation on this article.

Let's say that Jim, at Jim's Bait Shop, buys his stock from Bill's Wholesale Bait. Jim, as we saw in the previous articles, wouldn't have to pay tax because he's buying it for resale. The most fundamental sales and use tax exemption is for resale. So Jim's got nothing to worry about. Obviously, he will charge his customers tax on the bait and other tackle that he sells.

Scenario 1

Jim got up this morning and decided to take the day off and enjoy his favorite hobby, you guessed it, fishing. So he stops in at the store, takes a tub of his Special Blend out of the cooler, leaves a note for Burt, his bookkeeper, and heads off in the boat.

Now the state wants some money. When Jim bought that bait, he said he was buying it for resale. Which was true at the time. But then Jim changed his mind and took some of the inventory and "converted it to use." In other words, he didn't resell that particular tub of bait. He used it.

Hopefully, Burt has been to a seminar or two and knows about this problem. If he does it right, he'll be making a journal entry to reduce the inventory for that tub of bait, and he'll also be accruing the 8% use tax as well. Since Jim didn't pay sales tax when he bought it, he now owes use tax when he uses it instead of selling it.

Scenario 2

Jim does a chamber of commerce show and gives away small tubs of Special Blend at his booth. He used them as advertising premiums, therefore he owes use tax. Remember, he didn't pay tax when he bought the bait. But now he's used it. He's converted his inventory to use.

Scenario 3

Then there's Mary Kay. Mary Kay is a champion in bass fishing tournaments. She likes Jim's Special Blend and proposes a sponsorship deal. She'll use his bait (and wear the appropriate patches, etc) if he gives her 100 tubs of bait a year. He hasn't sold her 100 tubs of Special Blend, he's given it to her. Since he didn't sell it, he owes use tax on his cost of that bait. He used that inventory by giving it away.

Scenario 4

This applies to inventory that he gives to charity as well. Let's say the local Girl Scout troop wants to host a fishing derby (the stories just get weirder and weirder, folks) and they ask Jim for a donation of bait. Jim is happy to oblige and donates 50 tubs of Special Blend - essentially the same deal as with Mary Kay. You might think, "The Girl Scouts are tax exempt!" Yes, but not necessarily as far as Jim's donation. About half the states will say that Jim doesn't have to pay use tax on donated inventory. The other half will make him pay. You need to check the law in the relevant state.

Scenario 5

Finally, an old customer, Tony storms into Jim's establishment and demands a refund. The "Special Blend" didn't work! Jim apologizes and says that he had trouble a couple of days ago too. He offers Tony three tubs of the latest batch. Tony leaves happy. Jim leaves another note for Burt. Burt will have to make another journal entry reducing inventory and accruing the use tax on those three tubs because Jim used them by giving them away.

The term I used earlier, and that I've used for a long time is "conversion to use." Jim converted his inventory, which wasn't taxable, to use in all five examples above. Which means Jim owes use tax.

So the take-away here is that, if you sell stuff, you need to account for any situations where your stuff is taken out of inventory and wasn't sold. If you use it on your own, give it to a customer for goodwill or as a prototype, use it as a advertising premium or in trade, or give it away, you owe use tax. You used it.

About the only situation where your inventory can "go away" without you owing use tax is if you throw it away. And I've seen at least one state where manufacturers would have to consider scrap materials thrown away as used.

By the way, it's easy for a sharp auditor (big assumption) to catch this one. Remember poor old Burt. He's been making journal entries to reduce the inventory each time Jim gives away some inventory. All the auditor has to do is go through the inventory general ledger account and look for any entries reducing inventory for purposes other than sales and she's got you.

The solution is actually pretty simple. Whenever you make a journal entry to reduce your inventory, make sure you check to see if you owe use tax. And accrue it if you do.

Sales Tax Guy

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Do I have to pay use taxes on my inventory?

Whenever I start talking about use taxes, the question almost always comes up about whether someone needs to pay use taxes on their inventory.

We need to make sure we know what inventory means. Here are some questions:

1. Did you buy it with the intention of reselling it?
2. Have you changed your mind about that?
3. Are you using it as a demo unit?
4. Have you given it to someone to use but you're still holding it on the books as inventory?
5. If you're using it as a display item, do you intend to sell it for pretty close to the original price?
   

If you answered "yes" to the first question and no to the rest, then no matter how long you hold the inventory, you shouldn't owe use tax on it. You bought it for resale and that's one of the most fundamental exemptions for sales and use taxes. Even if you move it from state to state, you still owe no use tax.

Unfortunately, there are other taxes which may apply - such as personal property taxes (in some states).

But with regard to sales and use taxes, you should be off the hook. Just watch your answers to those five questions. Because if you answer wrong, then you've used the inventory and you will owe use tax.

More about withdrawals from inventory here.

Sales Tax Guy

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The Four Loopholes (Loophole Number 3)

There are four loopholes which created the need for use tax. Over a short period of time after inventing sales tax, the states started discovering that there were some situations where they weren't able to get the sales tax revenue they were expecting. We'll use this series of posts to discuss each one.

Withdrawal from Inventory (or Conversion to Use)

What's the fundamental and almost universal exemption?

OK, I'll tell you. Resale! Because sales and use taxes are generally intended to be imposed on the final consumer, the retailer shouldn't have to pay taxes on his or her purchases that will be resold to others. Read more in this incredibly well written article. And we have a lot of articles connected with this topic - including this one.

The loophole arises when a retailer buys stuff to resell, then turns around, changes their mind, and uses it. A lumber yard uses some building materials to build a new shed. A store takes picnic supplies out of inventory for a company outing. A computer store takes a price tag off of a laptop and gives it to the new guy. And the car dealer gives sales reps demos to drive.

These are all examples of withdrawal from inventory or conversion to use. I prefer the second term, but you'll see the first term more often in your research.

This was a loophole. If the state only has a sales tax, they don't have an obvious way of recovering the tax that the retailer should have paid at the time of purchase - on the building materials, picnic supplies, laptop or car. So the states invented use tax. When the retailer uses his goods by withdrawing untaxed stuff from inventory, the states can now get their money.

And if you read the instructions for your sales and use tax return, you'll usually see this particular item mentioned as one of the types of things that belong in the "use tax on your purchases" line.

More on this topic, with more illustrations, here.

Sales Tax Guy

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